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Realized or Unrealized gain (loss) for Taxation of foreign-currency transaction

Realized or Unrealized gain (loss) of Taxation for foreign-currency transaction




After you read this article, you will understand  about  Realized or Unrealized gain (loss)

Foreign-currency transaction

A foreign-currency transaction is transaction that requires settlement, either receipt or payment, other foreign currency. When the exchange rate changes between the original sale or purchase transaction date and the settlement date, there is a gain or loss on the exchange

About Currency

Functional currency: the currency of the primary economic environment in which the entity operates. In this case, we will consider whether our company operations use which currency as base. For example, we issued invoice ( revenue) and payment voucher ( payment ) using United States Dollar (USD) base, so functional currency is USD ($).

Foreign currency: a currency other than the functional currency of the entity. For example, if functional currency is UDS ($), so other currencies such as Cambodian riel (KHR), EUR(€),British Pound (£) etc​​ are foreign currency.

Presentation currency: the currency in which the financial statements are represented. Even functional currency is UDS ($), Financial statements such as income statement, statement of financial position or statement of cash flow my use different currency to show public. For example, ABC Company run business in Cambodia even functional currency is UDS ($), reporting /presention currency is required Cambodian riel (KHR) to General Department of Taxation (GDT).

About Exchange Rate

Closing rate: the spot exchange rate at the year end date. For Cambodia, if you submitted annual tax return, annual average exchange rate is issued by General Department of Taxation (GDT) is closing rate for preparing annual tax return ( Tax on Profit/Income).

Sport exchange rate: the exchange rate for immediate delivery. For example, Today is 27 January 2018 and exchange rate is $1=4,000 KHR, we have USD 2,000, and if we will convert USD 2,000 to KHR 8,000,000 today, so sport exchange rate is referred 1$=4,000 KHR.

Exchange rate: the ratio of exchange for two currencies.  For example, $1=4,030 KHR.

Internal Rate: the rate is determined by each company or entity for internal purpose. For example, ABC Company set $1=4,000 KHR for​​ January, and company will adjust each month, but in practice, some companies may set fixed rate per year ( $1=4,000 KHR). So different exchange is realized or unrealized gain or loss on exchange rate.

About Realized or Unrealized Gain or Loss on Exchange Rate 

Realized gains or losses occurred from completed transactions. For example, your pocket cash is USD, you converted or exchange to other currencies (e.g. KHR).

Unrealized gains or losses have occurred on paper, but the relevant transactions have not been completed. An unrealized gains or losses are also called a paper profit or paper loss because it is recorded on accounting system/paper but has not actually been realized.  For example, your pocket cash is USD, it is still USD. You only adjusted from exchange rate( e.g. $1=KHR 4,000) to another exchange rate ( e.g. $1= KHR 4,040).

Example about Realized or Unrealized Gain or Loss on Exchange Rate 

Example 1 unrealized loss on exchange rate

Assume base currency ( referred to functional currency) is USD, and your recording in accounting system is mono currency accounting USD ( e.g. KHR-USD Cash Account in accounting system equal $200 mean that $200 represent KHR on hand or bank because it equivalent amount).

Your Company, ABC, have KHR-USD Cash Account of $200 and internal rate is set $1 =KHR 4,000 for January. Your policy is monthly adjusted internal rate. February is set internal rate is $1 = KHR 4,100.




Required:

  1. Is it realized or unrealized gain or loss on exchange rate for February?
  2. Calculate gain or loss on exchange rate for February
  3. Make any accounting adjustment for February

Solution:

  1. It is unrealized loss on exchange rate because your pocket cash is KHR, it is still KHR. It means that your company has KHR 800,000, your company still has KHR 800,000 because your accounting system is recorded as KHR-USD Cash Account.
  2. Unrealized loss on exchange rate

$1 = KHR 4,000 , so KHR 800,000 = $200

when $1 = KHR 4,100, so KHR 800,000 = $195 ( 800,000/4,100=$195.122)

So Unrealized loss on exchange rate = $5

3. Accounting Record for February

Dr. Unrealized loss on exchange rate…$5

Cr. KHR-USD Cash…………………………….$5

You can verify your pocket KHR. For January, $200 x 4,000 = KHR 800,000, so January has KHR 800,000. For February, $$195.122 x 4,100 = KHR 800,000, finally January amount equal February amount, so it is called unrealized loss on exchange rate.

For Cambodia Taxation, unrealized loss on exchange rate is non deductible expense for tax on profit ( income ) purpose.

Example 2 realized loss on exchange rate

According to example 1, assume that your company exchanged or converted KHR 800,000 to USD ($) with market exchange rate ( $1 = KHR 4,100) on February.

Required:

  1. Is it realized or unrealized gain or loss on exchange rate for February?
  2. Calculate gain or loss on exchange rate for February
  3. Make any accounting adjustment for February

Solution:

  1. It is realized loss on exchange rate because before your pocket cash was KHR,  now it is USD ($) on hand or bank.
  2. Realized loss on exchange rate

$1 = KHR 4,000 , so KHR 800,000 = $200

when $1 = KHR 4,100, so KHR 800,000 = $195 ( 800,000/4,100=$195.122)

So realized loss on exchange rate = $5

3. Accounting Record for February

Dr. realized loss on exchange rate…$5

Dr. USD Cash**…………………………..$195

Cr. KHR-USD Cash………………………..$200

* * USD Cash mean that $ cash in both accounting system and physical amount.

You can verify your pocket KHR and USD. For January, your pocket KHR and USD are KHR 800,000 and USD 0 (zero amount) respectively. But for February, your pocket KHR and USD are KHR 0 and 195 USD  respectively, so it is called realized loss on exchange rate because January has KHR 800,000, but Now February is KHR 0 ( zero amount).

For Cambodia Taxation, realized loss on exchange rate is deductible expense for tax on profit ( income ) purpose.

Example 3 – VAT ( Sale Tax) 

Assume that taxable VAT  ( Sale tax) will be paid to Tax admin of $200, but tax admin required payment as Cambodian riel (KHR).

Tax admin declared average rate for VAT is $1=4,100.

Internal rate is $1=KHR 4,000.

Market exchange rate (spot rate) is $1 = KHR 4,050.

Required:

  1. VAT Amount will be paid to tax admin as KHR
  2. It is realized or unrealized gain or loss on exchange rate ?
  3. Calculate gain or loss on exchange
  4. Make Accounting record

Solution :

  1. VAT amount will be paid to tax admin = $200 x 4,100 = KHR 820,000 .
  2. It is realized loss on exchange rate.
  3. Your internal rate is $1=KHR 4,000, so $200 x 4,000 = KHR 800,000.  But you need to tax amount to KHR 820,000, and market exchange rate converted to KHR is $1=KHR 4,050. So you will pay $202.47 ( 820,000/4,050) to get KHR 820,000 for tax purpose. It mean that you lose 2.47 ( $202.47 – $200).
  4. Make Accounting record

Dr.  Realized loss on exchange..2.47

Dr. VAT payable…………………….200

Cr. USD account……………………….202.47




For Cambodia Taxation, realized loss on exchange rate is deductible expense for tax on profit ( income ) purpose.

Note: you can convert from internal rate to tax tax, and from tax rate to market exchange rate, so it is the same answer.

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